Large US bank failure coming

Kenneth Rogoff, the Harvard Professor and former IMF Chief Economist shares my view that another large U.S. financial institution will go bust. I predicted this will happen before the end of 2008. He gives no specific date, but he does go on to present a rather somber view of the economic outlook in view of a credit crisis that is only half over.

The worst of the global financial crisis is yet to come and a large U.S. bank will fail in the next few months as the world’s biggest economy hits further troubles, former IMF chief economist Kenneth Rogoff said on Tuesday.

“The U.S. is not out of the woods. I think the financial crisis is at the halfway point, perhaps. I would even go further to say ‘the worst is to come’,” he told a financial conference.

“We’re not just going to see mid-sized banks go under in the next few months, we’re going to see a whopper, we’re going to see a big one, one of the big investment banks or big banks,” said Rogoff, who is an economics professor at Harvard University and was the International Monetary Fund’s chief economist from 2001 to 2004.

“We have to see more consolidation in the financial sector before this is over,” he said, when asked for early signs of an end to the crisis.

“Probably Fannie Mae and Freddie Mac — despite what U.S. Treasury Secretary Hank Paulson said — these giant mortgage guarantee agencies are not going to exist in their present form in a few years.”

Rogoff goes on to suggest that buyers of financial services shares should not expect outsized gains from their investments, even at this stage in the credit crisis — another view I share

“There was this view early on in the crisis that sovereign wealth funds could save everybody. Investment banks did something stupid, they lost money in the sub-prime, they’re great buys, sovereign wealth funds come in and make a lot of money by buying them.

“That view neglects the point that the financial system has become very bloated in size and needed to shrink,” Rogoff told the conference in Singapore, whose wealth funds GIC and Temasek have invested billions in Merrill Lynch and Citigroup

In response to the sharp U.S. housing retrenchment and turmoil in credit markets, the U.S. Federal Reserve has reduced interest rates by a cumulative 3.25 percentage points to 2 percent since mid-September.

Rogoff said the U.S. Federal Reserve was wrong to cut interest rates as “dramatically” as it did.

“Cutting interest rates is going to lead to a lot of inflation in the next few years in the United States.”

While Rogoff and many others make a very good case for that 70’s show globally i.e. stagflation, I see a Japanese scenario as the likely outcome in the US.

Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty five years of business experience. He has also been a regular economic and financial commentator in print and on television for the past decade. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College.

It’s good to see some people with realistic views. Not later than today I saw this article on the WSJ (https://blogs.wsj.com/economics/2008/08/18/ucla-professor-says-us-is-still-far-from-recession/) where this professor claims that the US is far from recession.If you define as growth as “Growth of GDP when understating inflation by 5%” then yes, the US has been growing for the past 5 years. Otherwise, it’s been in recession for a long time now and the crisis is far from over.The DJ INDU and Russell 2000 have negative EPS! When the markets finally get rational, the readjustment will definitely put many banks and asset managers in the hole…

MAB says 10 years ago

Ed,

Per the following Bloomberg article, Citi has over $1 trillion of off balance sheet assets. Financials smell like Enron to me. Absent Government & Fed intervention, it's likely we would have had a collapse of the financial system. Excessive leverage is a killer – especially on top of peak historical asset valuations – for all asset classes.

FWIW, I see both inflation AND deflation. Inflation in needs (CPI), deflation in wants (real estate, equities, non-treasury bonds, credit). As for inflation, I don't foresee numbers as high as the 1970s. But on a REAL basis, it will feel like the 1970s for the average joe. 3 to 7% CPI inflation against a backdrop of falling or stagnant income is inflationary pain.

The best investment gains during the last ten years have come from leverage (private equity, real estate). Even commmodity futures have huge leverage. I don't see that continuing. In fact, I see it unwinding. Lots of bagholders – pensions, endowments, homeowners. I'll be a bagholder in the end too after the government is finished with all the bailouts. GRRRRR!

Now is the critical time to see what the global economy is made of. Can we avoid a brutal readjustment and spread the pain over a longer period? The Fed hopes so. That's why Fed Funds are 2%. However, the readjustment will still leave the S&P short of earnings. So valuations and share prices will have to fall. Certainly asset managers and banks will be in the hole as a result.

I haven't really tackled pensions and endowments yet. That is a topic we'll have to take a look at.